Offer Free Checking, Then Cross-Sell

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April 18, 2012 | COMMENTS

Free checking is many things, but for financial institutions it’s never “free.”

Maintaining a checking account costs financial institutions between $250 and $450 a year, according to Moebs Services, a Chicago-based research firm. In many cases those accounts aren't even turning a profit.

The average checking account cost institutions $349 in 2011, the firm’s principal, Mike Moebs, tells American Banker. But the average revenue per account is only $268, implying a loss of $81.

That equation underlies the thinking behind some of the recent controversial steps banks have taken to raise the prices their customers pay for checking accounts.

One-third to one-half of checking account customers are now unprofitable for banks, says Hank Israel, a partner at New York-based consulting firm Novantas.

The mismatch between the costs and the returns of checking accounts is untenable for the industry at large. But analysts caution that the solution is not likely to be one-size-fits-all. In part, this is because the costs to maintain checking accounts can vary widely across institutions of various sizes.

For banks with assets greater than $50 billion, the average checking account costs between $350 and $450 a year, according to Moebs. Overhead is what weighs down some of the largest banks, making it more difficult to cut costs, he says.

For some of the smaller institutions with less than $5 billion in assets, the costs are much lower—around $175 to $250 a year. The sweet spot for breaking even or squeezing out a profit on free checking is likely to be among the mid-sized institutions.

The issue comes down to efficiency and economies of scale. Institutions likely to fare best are those that are big enough to support a sizeable base of checking account customers, but which are not loaded down with ancillary costs.

"The community banks and the credit unions will offer free checking and will get revenue from overdrafts and other transaction revenue, and it's enough for them to break even," says Moebs. For those institutions, offering free checking brings more consumers in the door—creating opportunities to cross-sell and get more business. “That's the true purpose of free checking," Moebs adds.

Such a strategy isn’t likely to be sustainable for the megabanks. “The big guys are operating checking at a loss," says Moebs. "They have to get out of this business because with cuts to interchange and overhead revenue, they don't have enough to cover their costs."

But Israel of Novantas cautions that free checking may not be a winning solution for all smaller institutions. He notes that those customers who are transferring accounts in the current environment are more likely to be the unprofitable customers.

"The accounts in motion tend to be lower in deposit levels and less complex relationships," says Israel. Those accounts are the easiest to move from one financial institution to another, and they’re less susceptible to offers from larger banks trying to improve account quality.

Checking account fees are designed to recoup the costs of serving customers who keep small deposits, complete few transactions each month, or have not bought higher-margin services like mortgage loans.

If small institutions offer free checking without considering these factors, there could be “a deluge of customers seeking free checking,”  whether or not the institution has capacity to service them along with their more profitable clients, Israel says. "They can definitely move volume, but are they moving value?” he asks.

In late 2011, Moebs research showed 78% of credit unions offering free checking. That’s down from 85% in 2009, but still more than twice that of large banks, and more than community banks at 71%.